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Sample of Finance homework Illustrations and Solutions:

Illustration: 1. ABC Ltd. Is evaluating a capital proposal for which relevant figures are as follows:
Cost of the plant

$.

11, 00,000

Installation cost

$.

3,400

Economic life

7 years

Scrap value

30,000

Profit before depreciation and tax

2,00,000

Tax rate

50%

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Solution:
Annual depreciation charge
($. 11, 03,400 $. 30,000) /7

1,53,343

Profit before depreciation, and taxes

2,00,000

-Depreciation

1,53,343

Profit before Tax

46,657

-Tax @ 50%

23,329

Profit after Tax

23,328

+ Depreciation (added back)

1,53,343

Cash inflow (Yearly)

1,76,671

The plant has an initial cash outflow of $. 11,03,400 ($. 11,00,000 + $. 3,400), and its annual cash
inflows for 7 year/will be $. 1,76,671 p.a. However, in the 7th year, there will be an additional cash
inflow of $. 30,000 i.e., the scrap value. Therefore, in the 7th year, the total cash inflow will be $.
2,06,671.
It may be noted that the Examples 3.1 and 3.2 make an assumption that all the sales and expenses
have been affected in cash. However, in practice there is a time gap between the occurrence of sales
and expenses and their incidence on cash flow. Thus, each transaction of sales and expenses need to
be analyzed to find out the cash flow associated with it. Similarly, pattern of receipts from
receivables (debtors and bill) and the pattern of payments to payable (creditors and bills) should also
be analyzed to assess the effect on cash flow. But this is too difficult and rather impossible to apply.
Moreover, in capital budgeting, the emphasis is on yearly basis cash flows rather than intra-year
cash flows. Therefore, in capital budgeting, only the total cash flows are relevant and so, the profit
figure is adjusted only for non-cash items.

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Illustration: 2 A firm buys and asset costing $. 1,00,000 and expects operating profits (before
depreciation @ 20% WDV and tax @ 30%) of $. 30,000 p.a. for the next four years after which the
asset would be disposed off for $. 45,000. Find out the cash flows for different years.
Solution :
Initial Outflow:
Cost of the Asset $. 1,00,000
Subsequent Annual Inflows: The subsequent cash inflows from the asset may be found as under:
Year

1.

WDV

$. 1,00,000

Dep.

PBD

PBT

Tax

(2)

(3)

(4 = 3-2)

$.20,000

$.30,000

$.10,000

PAT

@30%

CF
(5)

(5 + 2)

$.3,000

$.7,000

$27,000

2.

80,000

16,000

30,000

14,000

4,200

9,800

25,800

3.

64,000

12,800

30,000

17,200

5,160

12,040

24,840

4.

51,200

10,240

30,000

19,760

5,928

13,832

24,072

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Terminal Cash Inflow :
Scrap Value of the Asset
Profit on sale:

$ 45,000
45,000

Sale Value

40,960

WDV (51,200 10,240)

4,040

Profit

$ 1,212

Tax @ 30% on $. 4,040

$ 43,788

Net Cash Inflow (45,000 1,212)

$ 43,788

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Illustration: 3

following is the income statement of a project, on the basis of which calculate the

annual cash inflows.

Income Statement of the Project

$. 4, 75,000
Net Sales revenue

$. 2,00,000

-Cost of goods sold

1,00,000

- General Expenses

50,000

3,50,000

-Depreciation

1,25,000

Profit before interest and taxes

25,000

-Interest
Profit before tax

1,00,000

-Tax @ 40%

40,000

Profit after tax

60,000

Solution:
The income statement of the project shows that an interest charge of $. 25,000 is payable on the
funds raised for financing the project. This interest payment is a charge for ascertaining the
accounting profit, but is irrelevant for ascertaining the cash flows. Therefore, the annual cash flow
from the project can be calculated as follows:
Calculation of Annual Cash Inflows
Net Sales revenue

$. 4,75,000

-cost of goods sold

$ 2,00,000

-General Expenses

1,00,000

-Depreciation

50,000

Profit before and taxes

3,50,000
1,25,000

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-Tax @ 40%

50,000

+ Depreciation (added back)

75,000
50,000

Net cash inflow

1,25,000

The cash inflow can also be ascertained as follows :

Net profit (as shown in Income Statement)

60,000

+ Depreciation

50,000

+ Interest

25,000
1,35,000

-Tax-effect of interest ($. 25,000 40%)

10,000

Annual cash inflow

1,25,000

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